Saturday, 30 July 2011

The repercussions of an economic slowdown in China

The Taiwanese know China better than most other people. That is why it is worth reading what Wu Hui-lin, aresearcher at the Chung-hua Institution for Economic Research, has to say about the deteriorating trend for China´s small and medium-sized companies, which contribute about 60% to China´s GNP and 80% of urban employment:

It is a well-known fact that China’s economy is going through great structural changes. Small and medium-sized enterprises (SMEs), which make up more than 99 percent of all Chinese companies, require a healthy operating environment and such an environment normally includes free entry to the market, fair competition, a mature and reasonable financial order, a sound legal system, transparent regulations and controls, as well as effective execution. However, for some time now the Chinese operating environment has placed major restrictions on the development of SMEs. In particular, these companies have been treated differently when it comes to financial assistance.

The interest rates on 62.3 percent of loans to SMEs are higher than the benchmark interest rate, while only 27.2 percent of large enterprises are subject to a higher rate. In addition, large enterprises receive more preferential loans. SMEs also tend to have less sound credit, which makes it difficult for them to obtain loans. Now that China is tightening access to credit, SMEs tend to be the first to have their loans put on hold by banks, compounding their already difficult situation.---Judging from the situation in China, the manufacturing industry is clearly deteriorating. While it is true that this sector has been affected by the continued appreciation of the yuan, rising raw material prices, rising labor costs and the international financial crisis, the factor that has most directly undermined the manufacturing and -processing industries is the difficulty accessing capital as a result of financial controls and tightening credit.

On April 30, an article in the Chinese magazine Economic Review revealed that many Chinese SMEs are experiencing problems.

Rising costs have led to declining profits and many businesses facing a situation where stopping production will cause them to close, while continued production will lead to an even faster demise. Needless to say, a wave of SMEs are having to close.One entrepreneur said that the biggest problems for Chinese SMEs is that: “Regardless of whether they are selling to the domestic market or for export, there is a clear shortage of orders and it is very common to see factories running at half capacity and making a loss. Even if they run at full capacity, they will not make any profits to speak of and everyone is doing all they can just to hold on.”---Last year, there were more than 10 million registered SMEs in China and the final value of their products and services was equal to about 60 percent of the GDP. They provided 80 percent of urban employment and their tax payments made up 50 percent of all tax revenue. SMEs are clearly vital to China’s economic and social stability, and the current wave of closures will undoubtedly have an impact on the nation.Now there is increasing talk of the Chinese economy’s possible collapse. Not long ago, “Dr Doom” himself, renowned economist Nouriel Roubini, included China’s demise as one of four factors in a perfect storm. Even those who used to have a bullish outlook are now changing their tune.

There are, of course, a number of other factors contributing to the risk of a serious slowdown in China, such as e.g. inflation and the looming real estate bubble.

The slowdown of the Chinese economy will without doubt have major repercussions in other countries as well. From a European point of view, Germany is the country that is going to be hardest hit, considering the importance of China in the German export success of recent years:

China is now Germany´s most important non-European export destination. As the Economist recently pointed out, German firms "happen to produce exactly the things that a booking China wants, from luxury cars to the machinery that enable Chinese factories to be the workshops of the world". Mercedes and BMW e.g. make 40% of their profits in China.

German investor confidence dropped for a fifth month in July, executives grew less optimistic and manufacturing growth slowed. German consumer confidence will drop for a fifth month in August, a survey by the GfK SE (GFK) market-research company showed on July 26.

Add the euro crisis and the financial turmoil in the US and you have the ingredients of a "perfect storm".